Futures
speculators are extraordinarily bearish on gold today. Their short
positions on it are extreme and unprecedented, the highest seen by
far in gold’s entire dozen-year secular bull. They expect downside
gold momentum to persist indefinitely. But despite their reputation
for sophistication, futures speculators are notorious for betting
wrong at extremes. Their bearishness is a very bullish
contrarian omen for gold.

Given gold’s
horrendous 2013 so far, you really can’t blame futures speculators
for being so pessimistic on it. Down 16.2% year-to-date, gold has
never suffered a worse calendar-year start in its secular bull.
American stock traders spawned a fierce gold headwind that global
buyers couldn’t overcome. To help raise cash to plow into the
euphoric, levitating stock markets, they aggressively dumped gold
ETF shares.

The epic
differential selling pressure on the flagship GLD gold ETF forced it
to sell massive
quantities of gold bullion to keep tracking its underlying
metal. Despite the lower gold prices sparking enormous physical
demand, particularly out of Asia, the wildly unprecedented deluge of
ETF gold overwhelmed all buying. As gold was pushed lower and
lower, it ignited a vicious circle that slaughtered futures traders.

Futures are very
different from any other market, they are a hyper-leveraged
zero-sum game. Leading into mid-April’s unheard-of gold panic,
American futures speculators could control 100 ounces of gold worth
$156k for just over $5k. Their maximum leverage was an
insanely-risky 29 to 1, radically beyond the decades-old limit in
stock markets of 2 to 1. Just a 3.5% move against them would
totally wipe them out!

After that
bloodbath of a magnitude never before witnessed, it is
understandable futures speculators remain scared of gold. The
sentiment damage wrought by extreme selling events is so
overpowering that it takes a long time for traders to recover. The
aftermath of 2008’s once-in-a-century stock panic is a perfect case
in point. Stock traders were so scarred by that trauma that they
remained bearish for years.

But the best time
to buy stocks wasn’t years later when sentiment finally started
recovering, but right at peak bearishness in March 2009.
When no bulls are left, when everything looks bleakest, is exactly
when bottomings happen as I
wrote at the time.
A similar extreme is happening today in gold, with futures
speculators nearly universally convinced that the yellow metal is
doomed to never rally again.

Thankfully
sentiment in futures is far easier to measure than in general
stocks. Every futures contract has a long and a short side. The
trader betting long (buying) is bullish, and the trader betting
short (selling) is bearish. So by tracking longs and shorts, we can
learn where futures speculators as a group think gold is heading.
And today they are overwhelmingly bearish, with speculators’ shorts
hitting bull records.

As a zero-sum
game, the total number of longs and shorts are always perfectly
equal. Every dollar won by one trader is a direct dollar loss for a
counterparty trader. But the US futures regulator, the Commodity
Futures Trading Commission, has long broken down futures traders
into three classes. The CFTC publishes a weekly report, the
Commitments of
Traders, that shows positions held by each trader class.

Formally called
commercial traders, non-commercial traders, and nonreportable
positions, these are more commonly known as hedgers, large
speculators, and small speculators. Hedgers trading gold futures
use this metal commercially in their own businesses, such as mining
or jewelry manufacturing. Speculators take the opposite sides of
the hedgers’ trades, simply betting on where gold’s price is heading
next.

So while total
longs and shorts among all three classes are always a wash,
within each class net-long and net-short positions arise. This
first chart looks at these class-specific net gold-futures positions
over the past 8 years or so. The speculators, both large and small,
have not been more bearish on gold for many years. And each past
time their bearishness hit extremes, gold soon started rallying
dramatically.

The CFTC releases
its CoT report late every Friday afternoon, with data current to the
preceding Tuesday. So these charts are current to May 28th, the
latest data available when this essay was published. On that day,
the gold net-long position among large speculators (including hedge
funds) fell under 57k contracts. This was down 52% since the week
before April’s gold panic, and down by 73% since early October.

Though it feels
like an eternity ago after 2013’s brutal bludgeoning, gold was
thriving and challenging $1800 again early last autumn. The carnage
has been so great since then that futures speculators have slashed
their net-long gold positions by nearly 3/4ths! Note they
were very bullish (high net longs) when gold was high and topping,
the exact wrong time. And now they are very bearish when gold is
low.

The last time
large speculators’ net-long positions had been so low was way back
in January 2007, 6.4 years ago. Were they right to be so bearish
then? Futures speculators, due to their willingness to take on
extreme leverage that would shatter a mere stock trader like me, are
often viewed as the smartest and most sophisticated of all traders.
But look at what gold did after these guys bet against it en
masse.

Over the next 14
months, it blasted 64.2% higher! While there are no doubt smart
individual futures traders, as a herd their track record is
dismal. They succumb to groupthink and buy into popular euphoria
and despair, extrapolating current trends out into infinity even
when they are overdue to dramatically reverse. This same extreme
bearishness was seen once again during late 2008’s crazy stock
panic.

In November 2008
as gold fell near $700, futures traders again abandoned this metal.
If it couldn’t surge during a once-in-a-lifetime stock panic, it had
to be dead right? The large speculators’ net longs fell to 64k
contracts, not much above last week’s levels. Then, like today,
everyone was utterly convinced gold could only keep falling. So
futures traders eagerly joined the popular gold-hyper-pessimism
bandwagon.

But again this was
the absolute worst time to be bearish on the yellow metal.
Just 13 months later, gold had soared 66.3% higher! Futures
speculators as a group were dead wrong, betting against gold
the most aggressively when they should have been the most bullish.
And this damning pattern continues back throughout gold’s entire
secular bull. Futures traders’ positions are a major contrarian
indicator.

In the chart
above, I used light-blue bars to highlight each time large
speculators’ gold net-long positions fell to major lows. If you
look at the gold price during each peak-bearishness episode and then
in the year or so after, without exception the yellow metal rallied
dramatically. The most sophisticated gold traders in the world, the
large futures speculators that include hedge funds, are always wrong at lows!

So why on earth
would they be right today for the first time in this mighty
12-year-old secular gold bull? Futures speculator net-long lows
have always been very bullish. When these guys get scared enough to
close longs and short gold en masse, soon everyone who is willing to
sell gold has already sold. This leaves only buyers, so gold soon
starts rallying dramatically. That is going to happen again today.

Small futures
speculators have a similar track record. They get most bearish on
gold as evidenced by their net-long positions right when the metal
is poised on the verge of a major new upleg. As shown in red above,
in early May these guys’ net-long position in gold futures actually
fell to -1.7k contracts. They were actually net-short gold!
How rare is this? It has never happened before in this
entire secular bull.

The last time
small specs were net-short was back in the winter of early 2001.
You may remember those dark days at the very end of gold’s preceding
secular bear, when this metal languished in the $250s! This means
just a month ago small specs were as bearish on gold as they were
just before gold’s current secular bull was born! This defies
belief, revealing the most extreme bearishness of this entire gold
bull.

The last time
small gold-futures speculators even came close to being net-short
was during late 2008’s stock panic. Once again that was the worst
possible time to be bearish, as gold would soon start surging in an
enormous rally that would run for years. Futures speculators
as a group simply get it wrong at extremes. They wax the most
bearish near lows when they should be bullish, and vice versa near
highs.

Contrarian trading
theory works because sentiment extremes are self-limiting and soon
burn themselves out. At toppings, as we’ve recently seen
in the stock
markets, greed grows so extreme that all available buyers have
soon already bought. That leaves only sellers, so prices start
falling and the great sentiment pendulum starts swinging back the
other way towards fear. Smart contrarians fight the crowd.

At bottomings,
like we’ve witnessed in gold in recent months, fear flares to such
extremes that everyone susceptible to being scared into selling has
soon already sold. That leaves only buyers, so as prices start
rising sentiment starts shifting back towards the greed end of the
greed-fear spectrum. The only way to buy low and sell high is to
buy when others are afraid and sell when others are brave.

The fear futures
speculators are showing in gold today, as exhibited by their short
bets, is extraordinary to unprecedented depending on the measure.
Extreme bearishness and extreme fear don’t breed further selloffs,
but major new uplegs. So the outlook for gold today is wildly
bullish, contrary to the widespread belief it is doomed.
Futures traders succumb to popular groupthink, leaving them dead
wrong at extremes.

This final chart
examines gold-futures speculator positions from another
perspective. It adds up the total longs and shorts held by both
large and small speculators. And as evidenced by the massive surge
in these traders’ short bets and the sheer quantity of their short
positions, they have never been more bearish on gold in its entire
secular bull. This is another powerful contrarian indicator that
gold will soon soar.

The red line
chronicles total speculator short positions in gold futures, and it
surged to an astounding 158k contracts last week. Since each
contract represents 100 ounces of gold, we are talking about
American futures speculators being short 15.8m ounces of
gold! To put this into perspective, the massive record GLD holdings
liquidation that crushed gold in 2013 is “only” at 10.9m ounces.
This short is gigantic.

Gold’s secular
bull was born in April 2001, so I haven’t bothered pulling CoT data
before 1999. And in that entire span from 1999 to today, we’ve
never seen gold speculators’ total short positions get anywhere
close to 158k. The previous bull record was only around 108k in
early 2005, again just before gold started powering higher in a
mighty upleg. Even in the summer of 1999, peak secular-gold-bear
despair, they never exceeded 135k.

So we’re
definitely at a decisive secular-bull high far beyond anything
witnessed before in the past 12.2 years. And back in February
thanks to a GLD-selling-sparked
gold capitulation,
speculators’ total short positions rocketed higher by almost 90% in
just 4 weeks. This was their biggest monthly surge in 9.4 years!
So there is no doubt that futures speculators’ bearishness on gold
right now is epically extreme.

When speculator
short highs are coupled with speculator long lows, it marks bearish
extremes from which gold will soon surge higher. I highlighted
these combinations above in light blue again. Gold futures
speculators have relatively-low long positions and relatively-high
short positions at exactly the wrong times, right when gold is the
most bullish. And the magnitude of today’s shorts is staggering.

The main reason
high gold shorts are so bullish is because they signal an
unsustainable sentiment extreme. But a secondary reason is more
mechanical, short covering. Due to the extreme leverage
inherent in futures, shorting them is vastly more risky than
shorting stocks. Relatively small moves higher quickly ignite a
frenzy of buying as futures shorts rush to move their capital out of
harm’s way.

Thanks to April’s
futures-forced-liquidation-driven
gold panic,
margins on gold futures have been raised from $5400 per contract
before to $6400 now. So at $1400 gold, a speculator can control
$140k worth of gold for just above $6k. This represents
still-insane 22-to-1 leverage, which means a mere 4.6% move in gold
can totally wipe out the capital of traders betting the wrong
way. This is a very unforgiving game.

Once gold starts
rallying, speculators shorting gold futures have no margin for
error. They have to buy to cover their short positions as soon as
possible, which quickly feeds on itself. More buying forces gold
higher, making the race to close shorts even more frantic. That’s
why short-covering rallies are the biggest and fastest ever seen in
any market. This alone nearly guarantees a coming sharp gold surge.

No matter what
gold does, some speculators will still short it. So all 158k
contracts won’t be covered. But with futures speculators’ total
shorts so staggeringly high today, their buying will still be
incredible. Between 2009 and 2012, the average spec shorts in gold
futures were 65k contracts. So merely buying gold futures until
shorts are back down to the post-stock-panic average represents 93k
contracts of buying.

That is about
9.3m ounces of gold, or nearly 6/7ths of the total GLD bullion
liquation so far in 2013! So as gold starts moving higher, there is
going to be short covering on a scale never before witnessed in this
secular bull. The unwinding of any extreme futures position is
usually equally as extreme, as these hyper-leveraged traders can’t
waste any time once a price starts moving rapidly against their
bets.

So from a pure
futures standpoint, gold has never looked more bullish in its
dozen-year secular bull than it does today! These futures
speculators as a group always bet wrong at extremes. They
stubbornly ride momentum, popular greed or fear, even when it has
already peaked. They fail to see the major reversals coming because
they are not contrarians who’ve trained themselves to fight
prevailing market emotions.

But being a
contrarian, fighting the crowd at sentiment extremes, is the only
way to buy low and sell high. You want to buy when everyone is the
most bearish, because that’s when prices are the lowest. That
describes gold today perfectly. And you want to sell when everyone
is the most bullish, because that’s when prices are the highest.
And that too should sound familiar, just like the
stock markets in
May.

I’m not a futures
trader, and I built up the physical-gold foundation of my portfolio
well over a decade ago. My trading interest lies in stocks. And
across the entire stock markets, there is no more contrarian sector
than gold stocks. Because gold is hated and traders are
hyper-bearish on it, gold stocks have been sold down to
fundamentally-absurd
panic levels.
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stocks, none are more loathed than the juniors. Their stock prices
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a ten-foot pole. This extreme bearishness means their prices will
rally much faster than other gold stocks when gold’s next upleg
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The bottom line is
futures speculators have never been more short gold in its entire
secular bull than they are today. Their gold bearishness is epic,
off the charts. But despite their willingness to make
hyper-leveraged bets, these guys have always proven wrong at gold’s
extremes. Their gold pessimism peaks right as this metal is
bottoming before embarking on a major new upleg. This time is no
different.

Extreme fear is
never sustainable, it soon burns itself out and only buyers remain.
And the futures speculators short gold are going to play a major
role in this. As gold starts rallying again, they will have to buy
aggressively to cover their record shorts. This may very well
cascade into a short-covering frenzy, a buying panic. Today’s
incredible gold bearishness means another massive gold upleg is
imminent.